On global warming, what US can learn from Europe

Momentum is building in the United States to fight global warming. And the most popular proposal to do that, at the moment, is through a nationwide "cap and trade" system.

At least three major Senate bills incorporate the idea. Large corporations, including big oil firms that until recently opposed such regulation, are backing the approach in theory. On Friday, the United Nations is slated to release a key report on the scientific consensus on global warming, which will put even more pressure on nations to act, analysts suggest.

But the real trick to effective legislation is in its details, a lesson that the European Union (EU) has learned the hard way as it prepares to cut greenhouse-gas emissions next year under the Kyoto treaty. So many companies emit so much carbon dioxide that the potential market for emissions trading is huge. Missteps could be costly, involving billions of dollars in unwitting subsidies or penalties for industries.

"Cap-and-trade markets for carbon gases are definitely on their way to the US," says Andrew Ertel, CEO of Evolution Markets, an energy and carbon-emissions trading firm in White Plains, N.Y. "The lesson from Europe is to keep it simple."

In theory, cap-and-trade systems hold much promise. They allow companies to find the most cost-effective way to reduce emissions. If one firm finds it cheap to cut its emissions below its federally mandated cap, then it can sell the difference – known as a carbon emissions allowance – to a firm that finds it much more expensive to cut emissions. As the government tightens the cap, credits get more expensive, which pushes companies to trim emissions.

Trading is harder in practice

In practice, cap and trade is more difficult.

Under Kyoto, the EU has already used cap and trade to trim 100 million tons of C02 emissions, according to some estimates. Europe's experience, however, has not run smoothly.

European nations still lag in meeting carbon reduction goals. They mistakenly set their base-line emissions far too high, according to an October analysis by Point Carbon, a global carbon-data firm. So when European companies began to trim their actual emissions, they found they had far more allowances than they needed. The result: The price of emissions credits nose-dived last April, falling by two-thirds in a month.

The EU plan also handed out many of its allowances free of charge, rather than having them auctioned off, says David Hawkins, director of the Natural Resource Defense Council's climate center. That reduced the price of the allowances and sparked charges of a government giveaway to industries.

Finally, the EU has not laid out a decades-long plan that clearly shows how the cap will tighten, the Point Carbon study says. Instead, its plan stops at 2012, when the Kyoto limits expire, creating uncertainty in the business community over what happens next.

"One key lesson from Europe's experience is that the US must structure markets so they're fair to consumers and only reward companies for cutting emissions, not just for being effective in lobbying for large [numbers] of pollution allowances," Mr. Hawkins says.

Here in the US, pressure to regulate greenhouse gases is building.

Last fall, California unveiled its plan to cut its emissions 25 percent by 2020. Most expect a California trading program, although it isn't absolutely mandated. In the Northeast, carbon-emissions trading is slated to begin in 2009 as part of a nine-state Regional Greenhouse Gas Initiative.

In the Senate, at least four major bills include a market-based approach to reduce global warming (see table). Even President Bush, an outspoken opponent of the Kyoto treaty, spoke of dealing with global warming by reducing dependence on oil in his State of the Union address last week. He made no mention of mandatory carbon caps. Polls show a majority of Americans favor action on global warming, as do a growing body of religious leaders.

With the prospects improving for some kind of mandatory caps, some big companies have decided to engage policymakers on how tight regulations should be, who should be regulated, and how allowances will be allocated. Each decision could have a major impact on corporate profits – and the volume of emissions.

Last week, a coalition of 10 major corporations including Dupont, Alcoa, and General Electric called for "mandatory reductions" and "swift legislative action" to cut greenhouse-gas (GHG) emissions.

"For so long US industry was fighting any kind of GHG regulation," says Kyle Danish, a partner with Van Ness Feldman, a Washington law firm specializing in energy, the environment, and natural resources. "Now that it is appearing increasingly inevitable, they're starting to realize they have enormous stakes in all sorts of design issues. There are numerous lessons to be had from the European experience."

Caps face tough slog in Congress

Still, global warming remains a tough sell in Washington.

"The public is way ahead of Congress on climate change," says Frank O'Donnell, director of Clean Air Watch, a Washington environmental group. "There's this tension between what is scientifically appropriate and what is politically viable. Getting something enacted in this Congress is going to be a herculean task."

If and when Congress does pass mandatory caps on carbon emissions, perhaps its most important challenge will be to make the cost of emitting carbon-dioxide high enough to drive real change, analysts say.

At the moment, such emissions have no price tag in the US. Some 225 big US companies like Dupont and American Electric Power are already trying to slash their "carbon footprint" by voluntarily paying for "carbon offsets" that are traded on the fledgling Chicago Climate Exchange.

These offsets might be subsidizing energy-conservation projects or the building of windpower plants (which reduce the need for burning GHG-producing fuels).

The exchange reports that it has kept 10 million tons of CO2 out of the atmosphere over the past four years with such projects. But with US annual emissions totaling about 700 times that amount, making carbon costly is the key.

In fact, America's gargantuan billow of carbon gases could quickly become a robust $50 billion to $100 billion US market in carbon allowances, some analysts estimate. That's roughly two to four times the estimated carbon emissions that Europe traded last year.

If a business is energy efficient and a low-carbon emitter, it could earn emissions credits, selling those for profit. Electric utilities that rely on coal-fired power might find it cheaper to buy credits – or if the cost rises high enough, to build other types of generating facilities with fewer emissions.

Of the four major plans in the Senate, the one proposed by Sen. Jeff Bingaman (D) of New Mexico is the most detailed. If the costs of allowances soar, it would ensure that businesses pay no more than $7 per ton of carbon emitted.

Would carbon costing $7 per ton be an adequate spur for electric utilities and homeowners to cut energy consumption substantially?

An Energy Information Administration analysis released earlier this month finds it would cut greenhouse gases by only 2.6 percent annually between 2012 and 2021.